Merger Arbitrage Analysis And Spread Performance - March 8, 2020
Summary
- Red Robin Gourmet Burgers suffers as coronavirus fears hit eat-in restaurant.
- Pattern Energy Group moves higher on better than expected results.
- Average all-cash merger arbitrage spreads widen significantly for the second week in a row.
This article explains the reasons behind the movement in a selection of the largest U.S. cash merger arbitrage spreads from the past week as calculated by Merger Arbitrage Limited. We analyze the attractiveness and profitability of each spread going forward and indicate the trading position or action we have taken or intend to take based upon the analysis given.
Red Robin Gourmet Burgers (RRGB)
Red Robin suffered the worst decline in its history (for the second week running) last week as the markets began to price in the effect the coronavirus will have on eat-in restaurants. Things started bad, in-line with the broader market, but as the week progressed the spread of the virus in the U.S. caused investors to bail from the sector en mass. Thursday saw the largest decline which spilled over into Friday. By the end of the week, RRGB had closed down $9.00 at $18.50 against an offer price of $40 from Vintage Capital. A fall of 32.73% leaves the simple spread at a whopping 116.22%.
Data by YChartsThe speed and pace of change of the market in this environment makes it difficult to remain current in terms of offering investment analysis. As can be expected, we have taken a severe loss on our RRGB position although the P&L is somewhat mitigated via the employment of our active arbitrage strategy. By a strange irony, it is possible RRGB management, in combination with the coronavirus may have pushed the firm into such a position that Vintage Capital may choose to walk away under these circumstances. A situation pleasing to management but disastrous for the arbs. If Vintage remain committed to doing a deal, and should the macro environment continue as it is, it is highly likely the offer will be revised lower. Should the wider economic scene return to "normal", sooner rather than later (a situation we highly doubt), Vintage could resume their hostile takeover approach under their initial analysis. For the time being we will hold our positon although we expect further volatility for the restaurant sector.
Pattern Energy Group (PEGI)
One tiny bright spark of hope in the cash merger arbitrage world that shone out above the rest this week was Pattern Energy Group (PEGI). Making a rare appearance in the largest movers category the stock announced earnings on Monday along with declaring a dividend of $0.422. A solid earnings performance has helped underpin the stock that has rarely traded below the offer price of $26.75 from the Canada Pension Plan Investment Board.
A report by Raymond James midweek suggested no higher offers would be made for the company. In light of the recent economic turmoil, this appears a rather obvious piece of analysis. However, despite this conclusion the stock drifted upwards through the week and even after a drop on Friday, closed up $0.13 for the period at $27.18. This is $0.43 above the $26.75 offer price from the Canada Pension Plan Investment Board. We had previously noted the SC 13G filings suggesting that hedge fund positioning could suggest a higher bid is a possibility, however, in the current environment this would be an extremely brave call.
Merger Arbitrage and Market Data
The broader market had yet another volatile week as traders witnessed the spread of the coronavirus on domestic soil. The very real possibility of a global economic slowdown is forcing traders to adjust their growth prospects for the year as governments desperately try to contain the outbreak. Falling markets have led to a flight to quality and following the interest rate cut the treasury yield now stands at 0.79%. The market volatility almost completely overshadowed February's employment report showing that the U.S. economy added 273,000 jobs. However, despite the volatile week, by the close on Friday, the S&P 500 ETF (SPY) finished up 11.16%.
The IQ ARB Merger Arbitrage ETF (MNA), however, had a reasonably more straightforward week until a decline on Thursday which continued through Friday put the ETF firmly in the red. (You can read our analysis of advantages and disadvantages of investing with the MNA ETF in the "Merger Arbitrage Strategy" section at the Merger Arbitrage Limited website). By the end of the week, the MNA was showing a loss of 2.67%.
Merger Arbitrage Portfolio Analysis
U.S. based cash merger arbitrage positions saw 18 declines against 2 advances this week with 0 non-movers. There were no cash positions last week as the index of cash merger arbitrage spreads maintains its full complement of deal constituents. The top 20 largest cash merger arbitrage spreads as defined by MergerArbitrageLimited.com fell by 4.97% and the dispersion of returns was 9.14%. This is significantly above any levels ever experienced in this metric using both the 3-month medium-term and long-term look back periods. The negative performance of the portfolio was attributable to the significant declines in RRGB and CY.
The index of cash merger arbitrage spreads now offers an average of 13.38%. This is more than double last week's figure of 5.39% and shows a violent reversal to what had been a gentle narrowing of the spread in previous weeks. For the coming week, the T20 portfolio has 20 deals and 0 vacant spots filled by cash.
Although last week we advised traders to consider (amongst other things) how regulatory approvals may be effected by the coronavirus, we were still surprised to see the cypress semiconductor announcement. This is a timely reminder how in spite of the over riding global concern about the virus, traders must still
- pay attention to deal specific issues such as regulatory compliance, and,
- these issues will occur of the life cycle of the investment strategy
One way to mitigate these issues is to understand when spreads have become too narrow at a portfolio level. When this is the case, even diversification will not be sufficient to save the portfolio from a disastrous P&L event. As always, given the opportunity in future editions, we shall explore these issues in greater detail over the coming weeks. For more immediate merger arbitrage discussion be sure to catch our exclusive interview with Seeking Alpha "SA Interview: Merger Arbitrage Investing With Mal Spink, CFA".
Merger arbitrage trading is not without risks. This strategy, although accessible to individuals as well as professionals, should be thoroughly understood BEFORE investment capital is put at risk. To assist the reader, "evergreen" content such as "how-to" & introductory guides, a reading list and much more including a list of the largest cash merger arbitrage spreads currently available can be found at the Merger Arbitrage Limited website associated with the author of this article.
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This article was written by
Analyst’s Disclosure: I am/we are long RRGB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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